This blog, written by Thomas E. Rutledge, focuses primarily on business entity law in Kentucky. Postings on contract law, contractual and statutory construction, and the entity law of other jurisdictions appear as well. There may as well be some random discussions of classical, medieval and renaissance history.

Friday, May 16, 2014

Massachusetts Further Adds to the Mess of Inter-Shareholder Fiduciary Duties

Massachusetts
Further Adds to the Mess of Inter-Shareholder Fiduciary Duties

Massachusetts has long been
infamous amongst those who practice business entity law for a string of cases
holding, inter alia, that the
shareholders of a business corporation, amongst themselves, owed to one another
the same fiduciary duties that are owed amongst partners in a general
partnership.Those cases include Rodd v. Donahue Electrotype Co. and Wilkes v. Springdale Nursing Home.A March decision of the Massachusetts Supreme
Court has continued this string of cases and in so doing demonstrated the
underlying fallacy of these supposed duties.Selmark Associates, Inc. v. Erlich,
5 N.E.3d 923 (Mass. 2014).

The underlying facts of the
case are rather involved, but they do not ultimate impinge upon the Court’s
analysis.Essentially, Erlich was a
shareholder in a close corporation and as well an employee thereof.In his employment role, he served as a sales
representative, and was the second most productive, in terms of commissions,
salesman for the company.The only
person more successful was the other shareholder.After working together for a number of years,
without prior notice, the majority shareholder advised Erlich that his service
as an employee was terminated effective immediately.Suit was brought for breach of fiduciary duty
and other claims.Meanwhile, the
minority shareholder, Erlich, went to work for a competitor of his former
employer, a corporation in which he remained a shareholder.Working for that new employer, Erlich
solicited customers of his former employer, and was successful in convincing at
least one to move their account.The
former employer then filed a counterclaim against Erlich for breach of his
fiduciary duties owed to the corporation.

The case would ultimately be
tried by a jury, its decision being appealed to the Massachusetts Supreme
Court.

As to Erlich’s claims for
breach of fiduciary duty in his termination from employment, the jury’s verdict
in Erlich’s favor upheld.Erlich had
been terminated “without warning on reasonable explanation” and there was “no
evidence of poor performance,” or “of an inability to get along with
others.”5 N.E.2d at 935.Ultimately, “Erlich has demonstrated that
[the defendant] could have sought less harmful alternatives before resorting to
termination.”Id.

Still, the victory was not
entirely for Ehrlich.He remained a
shareholder in his former employer, and in that capacity owed it fiduciary
duties.In going to work for a competitor
and soliciting customers to move to the competitor Ehrlich was working against
the interest of his former employer.Ergo, Erlich violated his fiduciary duties.Ehrlich argued against this analytic path,
asserting that:

because he was fired [ ] and
essentially “frozen out” [of this former employer], he had the right to compete
with [his former employer] without committing a breach of his fiduciary duties
to the company.5 N.E.3d at 943.

In rejecting
this argument the Massachusetts Supreme Court wrote:

Our cases are clear that
shareholders in close corporations owe fiduciary duties not only to one
another, but to the corporation as well.At issue here is whether those fiduciary duties to the corporation
continue once a shareholder has been “frozen out,” or wrongfully terminated, by
that corporation….

Allowing a party who has suffered
harm within a close corporation to seek retribution by disregarding its own
duties has no basis in our laws and would undermine fundamental and
long-standing fiduciary principles that are essential to corporate governance….
We see no reason to take such a drastic step. “If shareholders take it upon
themselves to retaliate any time they believe they have been frozen out,
disputes in close corporations will only increase. Rather, if unable to resolve
matters amicably, aggrieved parties should take their claims to court and seek
judicial resolution.” 5 N.E.3d at 943-44
(citations omitted).

This is Why I’m Glad to be in
the Commonwealth of Kentucky and Not the Commonwealth of Massachusetts

This
case demonstrates the utter silliness of imposing upon shareholders fiduciary duties
owed among themselves.Here we have an
individual, Ehrlich, who was otherwise an at-will employee of his
employer.However, simply because he was
a shareholder the terms of his employment were morphed into employment that
could be terminated only upon notice and for cause.At the same time the corporation became the
beneficiary, inter alia, of a
non-compete/non-solicitation agreement binding the shareholder.

Fortunately, Kentucky has not adopted fiduciary duties among
shareholders.See Rutledge, Shareholders
Are Not Fiduciaries – A Positive and Normative Analysis of Kentucky Law, 51
Louisville Law Review 535
(2012-13).Here is a LINK to that
article.See alsoMore Evidence that
Kentucky Law Does Not Recognize Fiduciary Duties Among Shareholders (March
20, 2013) – LINK.